Download Fundamentals of an Islamic Economic System Compared to the

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11|2010 KAS INTERNATIONAL REPORTS
Fundamentals of an Islamic
Economic System compared to
the Social Market Economy
A Systematic Overview
Volker Nienhaus
Underlying the scholarly interest in comparing economic
systems is often a tacit suspicion that, in view of the
arrested development of many Islamic countries, this
religious worldview is seemingly incompatible with a
market economy that promotes development. However, if
we consider the attitude of the founders of the religions,
Jesus and Mohammed, towards the economy and the
teachings and practices during the early phase of the
Christianity and Islam, it is actually quite surprising that
Christians raise doubts about the compatibility of Islamic
teaching with the market economy – from an historical
perspective, the reverse would have seemed more appropriate. On the other hand, we must remember that the
social market economy is a concept that was created for
highly developed and structurally differentiated economies
only in the twentieth century in the Western world, where
it has proved itself. In Islamic countries, most of which only
gained their independence in the middle of the twentieth
century, this concept was rather unknown.
In the light of the lasting development problems of many
countries of the Muslim world – stretching from North
Africa, across the Middle East to Southeast Asia – these
states have by no means ruled out the search for economic
concepts that promote development. Not least as a result
of disappointment with the results of the capitalist and
socialist economic systems, since the mid-1970s people
have been progressively formulating ideas about an Islamic
economic system, propagating them as an alternative
to the unsatisfactory status quo. Against this backdrop,
Prof. Dr. Volker Nienhaus was President
of the University of
Marburg. He is now a
visiting professor at
the ICMA Centre,
Henley Business
School, University of
Reading (United
Kingdom).
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KAS INTERNATIONAL REPORTS 11|2010
therefore, it is worth investigating the general principles
of the social market economy and their compatibility with
such economic systems in order to share the experiences of
our own economic system as part of the dialog surrounding
development policy.
Islamic Economics and the General Principles
of an Islamic Economic System
The task requires to compare an intellectual construct (an
Islamic economic system) with a concept that exists in
reality in different forms (the social market economy). By
contrast, no modern state in the Muslim world has practically implemented an Islamic economic system, perhaps
with the exception of Sudan and Iran. The economic
systems that exist today are more or less systematic
advancements of systems installed as a secular sign after
gaining independence in continuance of, or in a (revolutionary) triumph over colonial era systems.
The earliest publications on Islamic
economics did not originate from scholars at leading Islamic universities in
the Arabic core of the Islamic world, but
rather from academics in Asia.
Even the academic discipline of Islamic
economics, which seeks to combine secular
economic theories or (neoclassical) models
with teachings from Islamic philosophy and
law, is a relatively new phenomenon. The
earliest publications in this field did not originate from
scholars at leading Islamic universities in the Arabic core of
the Islamic world, but rather from academics in Asia. The
efforts of Indian Muslims, beginning in the 1930s, to create
a Muslim state on the former territory of British India
following Britain’s withdrawal gave rise to intense debates
about an Islamic economic system – or rather, debates
about an economic system for an Islamic State. Although
the new state of Pakistan was created in 1947 as a type
of “Muslim nation state” in parts of former British India, it
still had a very secular character and many questions on
the appropriate economic system had still not fully been
answered. The constitution of 1958 turned the state into
the “Islamic Republic of Pakistan,” but this did not bring an
end to discussions about economic policies that had been
going on since the 1940s. Instead, it intensified them.
People were looking for their own path, a path between
Capitalism and Communism, which would also drive
forward economic development. Most of the early treatises
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on Islamic economics (right up until the 1960s), which
have been reprinted and are still cited today, were written
against this backdrop.1 Similar discussions also took place
in the Arab world in connection with the withdrawal of
European colonial and mandatory powers from the middle
of the 1950s onwards – without the context of founding an
“Islamic” state.
During this early phase, many models had socialist traits:
the models of “Islamic Socialism” were based on a redistributive state, which heavily controlled the economy. Thus,
they contrasted starkly from laissez-faire
capitalism. However, for the most part they
did not question private ownership of the
means of production – a significant difference
compared with “godless” Communism. These
models could be described as variations of
References to Islamic teachings and, in
particular, to commercial law aspects
of Shariah were often only cursory or
cosmetic and served more to legitimize
and mobilize than provide a conceptual
foundation.
Market Socialism. References to Islamic
teachings and, in particular, to the commercial law aspects
of Shariah were often only cursory or cosmetic and served
more to legitimize and mobilize than provide a conceptual
foundation. With the continued “academification” of literature, the increasing involvement of experts in Islamic law
and more intense international discussions about Islamic
economics, it has become clear that dominant control of
the economy does not agree with private property and a
market-based system, and that prevailing attitudes are
increasingly moving towards a competitive economy with
a state that primarily seeks to ensure monetary stability,
proper competition, and a basic infrastructure (transport,
education, healthcare, legal system). Such a state should
pay particular attention to ensuring that income and wealth
do not become too concentrated, especially in poorer
countries, and initiate programs to fight poverty.
Over the past decade, public duties (both of society and the
state) have broadened to include safeguarding sustainable
economic activity and protecting the environment. Finally,
the state should create favorable framework conditions
for a private economy consistent with the requirements of
Islam, something which can have particular implications
1 | For an overview of early literature, see Muhammad Akram
Khan, Islamic Economics: Annotated Sources in English and
Urdu (Leicester: Islamic Foundation, 1983).
KAS INTERNATIONAL REPORTS 11|2010
Religion(en)
Ideologien
Systeme der umfassenden Weltdeutung
R
Moral
for bankecsupervision
and central bank policyHandlungsmuster
in an interestht
f
er
t
ig
unsystem,
free financial
Rechtfor example.
g
Fig.
1
Tradition/Kultur
Marktwirtschaft
Islamic Concepts of a Market Economy
between Economics and Law
Sunnah
Rules
Principles
Secular
Economics
Islamic
Economics
Islamic System
Quran
Fiqh
(Jurisprudence)
Systems
Design
Shariah
(Islamic Law)
Secular Law
Concept of
Market Economy
Contemporary
application of/
addition to Shariah
The prevalent
Islamic economics today
Science doctrine of Ideology
Religioncan be
summarized as follows:2
Prescriptiveness
▪▪Islam conveys a
Mobilization
Islamic
Economic
System
positive
outlook
on this
life in general
and provides Open
a supportive
value
system forLegitimacy
economic
Functionality
and Competitive
Markets,
Competition Policy
activities in particular.
Financial and Monetary Economy
▪▪Islamic economic
ethics exhibits considerable overlap
▪ Prohibition of riba
with
▪ Stabile moneyperceptions
(gold, 100%, …?)
Western-Christian
in
the
field
of
▪ zakat (social security contributions)
Specific Prohibitions
and Characteristics
in Sub-Systems
Individual
Social Security
individual ethics.
Greatand
importance
is ascribed to personal
achievement. ▪ takaful (mutual insurance)
▪▪Individuals areState
expected
earn
their
living through their
and the to
Public
Sector
Economy
Notions of a Social
Market Economy
78
▪ Legal framework
own work. A ▪person’s
own achievement (physical and
Infrastructure, environment
▪ Public
corrections
of
intellectual work)
is goods,
the most
important
basis for legitimarket failure
mately obtaining material goods and wealth.
System-/EntwicklungsPerspektive
kommerzielle Perspektive
2 | Cf. Khurshid Ahmad (ed.), Studies in Islamic Economics
und Ghazali
Ausdifferenzierung
Stabilität
in der
2010 ▪ Expansion
▪ überlegene
(Leicester:
Islamic
Foundation,
1980); Aidit
and Syed
des islamischen
Finanzsektors,
Finanzkrise
Omar (eds.), Readings in the Concept
and Methodology
of
aktive Beteiligung westlicher
▪ islamische Mikrofinanz und
Islamic Economics – Translating
Islamic Principles into Socio2000
Banken, wachsendes Interesse
finanzielle Inklusion
Economic Realities (Petaling Jaya:
Pelanduk Publishers,
nicht-islamischer
Länder 1989);
Ausaf Ahmad and Kazim Raza ▪Awan
(eds.),
Lectures
on
Malaysia:
von
der
Pro-Bumiputra1990
Islamic Economics (Jeddah: Islamic
and
Training
PolitikResearch
zum dualen
Finanzsektor
(Banken,
Kapitalmarkt,
Takaful,
Finanz▪ Islamisierung
Institute, von
1992);
M. Umer Chapra,
The Future
of Economics:
Regulierung
etc.)
Pakistan,
Sudan, (Leicester:
systemen:
An Islamic
Perspective
Islamic Foundation,
2000);
▪ Finanzdienstleistungen für
Iran
1980
Richard C. Foltz, Frederick
M. Denny and Azizan Baharuddin
Handelshäuser am arabischen
(eds.), Islam and Ecology: A Bestowed
Trust (Cambridge,
Golf: Scharia-Konformität
▪ abstrakte Modelle einer
Mass.: Harvard University
Press,
2003). Entstehung und
▪ Petrodollar,
1970
Erfolgsbeteiligungswirtschaft
und Geldreform
▪ Förderung der Entwicklung
1960
(Sparkassen-Projekt von
Wachstum eigenständiger
arabischer Banken
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11|2010 KAS INTERNATIONAL REPORTS
▪▪Neither individual human skills nor natural resources
should lie idle unnecessarily, and it is forbidden to waste
or wantonly abuse resources.
▪▪Legitimately acquired wealth should not be used to
maximize the pursuit of a person’s own wants (in this
life): luxury is frowned upon; Islam preaches moderation;
and the use of surpluses for social aims is meritorious.
▪▪The needy have their own claim to solidarity from the
community, which is institutionally protected and based
on the Quran: Muslims are required to pay zakat, i.e.
a two and a half percent levy on assets or a five or ten
percent levy on agricultural produce, which is used for
specific (social) purposes. This is an obligation for the
individual, and the claims of the needy should be satisfied
by the community or the society (and only then by the
state); this is very similar to the principle of subsidiarity.
▪▪Since Allah has made the goods of this world available
to all human beings, inequalities in the distribution
of income and wealth must not be allowed to become
too great. If needs be, the state must intervene with
corrective measures to fight poverty.
▪▪Humans, as God’s custodians of the earth, only have
the right to use creation. They must not inflict lasting
damage on it and must consider the legitimate claims
of future generations in what they do. This
principle gives rise, among other things, to
a collective ownership of non-renewable
resources
(natural
resources,
but
also
water) and, more recently, a duty to protect
Prices should be just, which means that
they should be based on competitive
markets. Monopolization and hoarding
lead to an exploitation of other market
participants and should be defeated.
the environment.
▪▪Islamic law recognizes private ownership of the means
of production. Nationalization and state control of the
economy are only permissible in exceptional circumstances.
▪▪Land and capital become productive only as factors of
production when combined with labour. Therefore, income
may not be derived from merely owning land or capital.
Financing, lease, and other contracts, which allocate
returns and risks to the owners of factors of production,
must meet particular criteria of justice.
▪▪Prices should be just, which means that they should
be based on competitive markets. Monopolization and
hoarding lead to an exploitation of other market participants and should be defeated.
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KAS INTERNATIONAL REPORTS 11|2010
▪▪Practices and courses of action that have antisocial
and other damaging consequences are forbidden, thus
implying that markets and competition should rule and
that monopolies should be prevented.
▪▪Furthermore, all transactions, where one party benefits
at the cost of another – just as with gambling and speculative trading –, are banned.
▪▪The objective of monetary policy is to ensure stability of
the price level.
▪▪Financial policy should preserve the equilibrium between
tax revenues and public expenditure so that the national
budget balances overall.
▪▪The state must provide a basic infrastructure (including a
judicial system) and particular public goods, and it should
refrain from intervening in competitive markets.
Essentially, this list contains all the elements that constitute
a social market economy, which have been summarized
in the Konrad-Adenauer-Stiftung’s publication entitled
“Guidelines for Prosperity, Social Justice and Sustainable
Economic Activity.”3
3 | Cf. Konrad-Adenauer-Stiftung, Guidelines for Prosperity, Social
Justice and Sustainable Economic Activity (Berlin: Konrad
Adenauer-Stiftung, 2009), http://www.kas.de/wf/doc/kas_
17025-544-2-30.pdf (accessed October 17, 2010).
11|2010 KAS INTERNATIONAL REPORTS
Table 1
Guidelines for a Social Market Economy and
Fundamentals of Islamic Economics4
Guideline4
Position of Islamic Economics
Legal framework
▪▪ Law and the rule of law are impor­
tant: linking government action to a
superior law – Shariah (which only
contains some directly applicable
economic content) and Shariahcompliant secular law (the formulation of which gives great creative
leeway)
▪▪ Concepts of an Islamic economic
system are compatible with different forms of government (democracy, monarchy, etc.)
Property ownership and
employment
▪▪ Legitimacy and protection of private
property, even relating to the means of production, positive assessment of entrepreneurial achievement (Prophet as a role model)
▪▪ One’s own work/achievements
should be the primary source of income and legitimate wealth, assets
must be used productively (desired
growth and employment effects)
Competition as a basis
▪▪ Justice is important: price fairness
Fair price = competitive price; state
protection of competition against
monopolization; occasional state
intervention in the case of
“sensitive” prices
Application of the principle
of liability
▪▪ Strong emphasis on opportunity
and risk (particularly in the financial
economy), skepticism towards
limited liability legal structures,
such as limited companies (now
acceptable), increasing importance
of corporate governance
Stability of the economic
environment
▪▪ Monetary stability is important:
various models for stability-oriented
monetary systems (gold standard,
commodity currencies, one hundred
percent money, monetary rules,
etc.)
▪▪ Regulation of financial markets (riba
ban, linking financial transactions
to the real economy, prohibition of
purely speculative trading)
4 | Konrad-Adenauer-Stiftung: Guidelines for Prosperity, Social
Justice and Sustainable Economic Activity, Berlin 2009.
81
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KAS INTERNATIONAL REPORTS 11|2010
Provision of public goods
by the state
▪▪ Provision of a basic infrastructure
(legal system, education, healthcare, mobility) recognized as a legitimate duty of the state; discussion
about science as a public good
▪▪ Correction of market/competitive
failure, no structural or procedural
interventionism
Solidarity and social security ▪▪ Poverty reduction as a primary
economic objective
▪▪ Zakat at the core of a social
security system that is independent
of the family (claim of the needy
in respect of society – state is
subsidiary)
▪▪ Calls for international solidarity
within the Islamic world (umma)
▪▪ basic principle of insurance that
conforms to Shariah Law (takaful):
mutuality, entry into a shared risk
community instead of purchasing
a risk coverage
Incentive compatibility
▪▪ Legitimacy of secular taxation (in
addition to zakat) is now uncontroversial; exact structure can be
defined according to time/place/circumstances, considering incentive
compatibility
Sustainability
▪▪ Allah is the ultimate owner, human
beings are merely custodians, duty
extends to future generations (idea
of sustainability)
Open markets
▪▪ In principle, for all open goods,
services, and labor markets, but
reservations with capital markets
(issue of interest, speculative
capital transactions)
Neither the duties of the state nor the major economic
sub-systems differ in functionality from those of Western
systems; and Islamic economists draw on secular (mainly
neoclassical) theories in order to explain the mechanics
of sub-systems, such as goods and factor markets, or
the monetary system. The Islamic component within the
relevant systems is not the functionality of the elements,
but the justification for their design and combination.
This is achieved by reference to Islamic teachings and
argumentation patterns.
Design
Shariah
(Islamic Law)
83
Concept of
Market Economy
Contemporary
application of/
Elements and Superstructure ofaddition
an
to Shariah
Fig. 2
Secular Law
11|2010 KAS INTERNATIONAL REPORTS
Islamic Economic System
Ideology
Science
Prescriptiveness
Religion
Mobilization
Islamic Economic System
Functionality
Legitimacy
Open and Competitive Markets,
Competition Policy
Individual and Social Security
▪ zakat (social security contributions)
▪ takaful (mutual insurance)
State and the Public Sector Economy
▪ Legal framework
▪ Infrastructure, environment
▪ Public goods, corrections of
market failure
Specific Prohibitions
and Characteristics
in Sub-Systems
Notions of a Social
Market Economy
Financial and Monetary Economy
▪ Prohibition of riba
▪ Stabile money (gold, 100%, …?)
kommerzielle Perspektive
System-/EntwicklungsThere
are two exceptions to this statement
within Islamic
Perspektive
economics – particular sub-systems that do not just
▪ überlegene Stabilität in der
2010 ▪ Expansion und Ausdifferenzierung
combine
with
justifications
taken
islamischen
Finanzsektors,
Finanzkrisewell-known elementsdes
aktive
Beteiligung
▪ islamische
Mikrofinanz
und
from
Islamic
teachings,
but also
require
thewestlicher
implemen2000
finanzielle Inklusion
Banken, wachsendes Interesse
tation of functionally distinct Islamic
institutions.
nicht-islamischer
Länder On the
von der
Pro-Bumiputra1990 ▪ Malaysia:
one hand, this is the interest-free
financial
sector
(banks,
Politik zum dualen Finanzsektor
capital
markets,
and insurance)(Banken,
and, onKapitalmarkt,
the other, Takaful,
a social
▪ Islamisierung
von Finanzetc.)
systemen: Pakistan, Sudan,
security
system with zakat at itsRegulierung
core.
1980 ▪ Finanzdienstleistungen für
Handelshäuser am arabischen
Golf: Scharia-Konformität
▪ abstrakteSecurity
Modelle einerBased on Zakat
Social
Erfolgsbeteiligungswirtschaft 1970 ▪ Petrodollar, Entstehung und
Wachstum eigenständiger
und Geldreform
arabischer Banken
▪
Förderung
der
Entwicklung
Zakat is a levy paid by Muslims,
whose wealth exceeds a
1960
(Sparkassen-Projekt von
particular
Mit Gahmr)exemption allowance, and it is used for social
▪ Suche nach einem eigen1950
purposes,
details of which
are set out in the Quran.5 The
ständigen Wirtschaftssystem 1940
act
of paying zakat is one of the most fundamental religious
(Pakistan)
Iran
duties for a Muslim. Islamic economics emphasizes that
Funding
Application
Modern
Analogies
Basis G. de Zayas,
Entitled
5 Historical
| Cf. Farishta
The
Law and Institution
of Zakat
of Assessment
Recipients
(Kula Lumpur: The Other Press, 2003 [first published:
Damascus: Al-Jadidah Press, 1960]); Mohammed Akhter
▪ Gold
Saeed
Siddiqi,
Early Development
Zakat Law
and Ijtihad
▪ Poor
and silver
General
SocialofSecurity
▪ Needy El-Ashker
capital
levy?
▪ Livestock
(Karachi: Islamic
Research
Academy, 1983); Ahmed
goods
▪ Trade
and
Sirajul Haq (eds.), Institutional Framework of Zakah:
▪ Agricultural
Dimensions and
Implications (Jeddah:
IRTI, 1995); Volker
General
Extensive inter- ▪ Debtors
produce
Nienhaus, “Zakat,
Public Finance
in
Islam,” in:
▪ Travellers
incomeTaxes,
levy? and pretation:
for
Sohrab Behdad and Farhad Nomani
(eds.),
Islam
and the of
▪ Redemption
nearly all
governSlaves and
ment
duties (Abingdon
Everyday World – Public Policy
Dilemmas
▪ For converts
▪ OneNew
York:
Routledge,
of the
highest
duties of 2006),
a Muslim165-92.
▪ Basis in the Quran and Sunnah, details from Caliphs
▪ Social security system independent of the family
▪ Elements of solidarity and subsidiarity
to Islam
▪ For warriors
of Islam
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KAS INTERNATIONAL REPORTS 11|2010
zakat represents the needy’s claim to share in society’s
wealth and, as such, is at the core of the social security
system. The zakat system can be organized by the state if,
for example, Muslims fail to perform their payment duties
adequately on a voluntary basis. Unlike taxation, the
state may not use zakat revenues for the general budget.
Instead, they may only be used to help entitled recipients
for the purposes set out in the Quran. Nevertheless, there
is a need to reevaluate and clarify these legitimate uses and
recipients in light of modern developments. In addition,
the form in which the zakat funds are supposed to be used
(e.g. as direct monetary transfers or to finance institutions
which provide benefits to the entitled recipients) must also
be determined.
The example of zakat illustrates the principle of pragmatic
legislative development which, on the one hand, allows
flexible adjustments to be made to the legal system in view
of new phenomena or changed conditions,
The literature often gives the impression that the Prophet implemented an
immutable zakat system on the basis
of the Quran that is valid for all time.
That is not the case.
but also leads to controversy and partisan
inconsistencies on the other. The literature
often gives the impression that the Prophet
implemented an immutable zakat system
on the basis of the Quran valid for all times.
That is not the case, however: the basis of assessment
for zakat laid down by the Prophet was changed by his
immediate successors as well as the levy rates.
For the early caliphs, the zakat rules of the Prophet were
evidently not considered invariable rules given by God,
but merely an expression of (revisable) legislation which
depended upon particular circumstances, a particular
period, and a particular place. Such pragmatic legislation did not seek to establish universally applicable and
timeless principles; rather, it aimed to solve particular
problems. The pragmatic legislation of the Prophet and the
early caliphs did not produce universal principles; rather
it provided analogies based on previous cases to assist in
new, individual instances.
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The Prophet listed the following assets (and sources of
income), which were to be subject to zakat payments
(basis of assessment):
1.camels, sheep, and cows,
2.gold, silver, and coins,
3.wheat, barley, dates, and grapes,
4.buried treasure.
It is unclear whether he also levied zakat on honey and
trade goods. When one of the early caliphs had to decide
whether zakat was also payable for horses, for example, he
only reached a decision for that specific instance and left
open the question of whether other animals, such as goats
or donkeys, should also be subject to zakat. Later judges
widened group 3 to include rice in the list of
produce subject to zakat. In so doing, they
based their decision on an observation that
all objects in this group originally covered
foodstuffs; thus, rice – as a foodstuff –
should also be included. Yet, it is peculiar to
There continue to be food products for
which producers do not have to pay
zakat. Economists view this lack of
consistency as problematic from the
point of view of non-discrimination or
fairness.
the pragmatic legislative development that
a decision is reached only for a specific case (rice), but
no generalization or postulation of the principle used in
reaching that decision is made – e.g. that all foodstuffs
should become subject to zakat. Thus, there continue to be
food items for which producers do not have to pay zakat.
Economists view this lack of consistency as problematic
from the point of view of non-discrimination or fairness.
From this perspective, deciding on a case-by-case basis by
way of analogies also causes further problems of justice:
There are small rice producers in Asia, for example, who
are required to pay zakat, while owners of rubber plantations remain exempt. If this inequality is to be avoided, all
agricultural, forestry, and plantation produce, as well as
revenues or profits derived from the respective businesses
should be subject to zakat levies. In that instance, however,
the question must be asked why zakat is only levied on
revenues or profits from the primary sector, while profits
from the secondary and tertiary sectors remain zakat-free.
Such considerations, though, would require a complete
abandonment of the established methods of pragmatic
legislative development and a move towards a type of
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KAS INTERNATIONAL REPORTS 11|2010
“constructivism in the spirit of the Quran.” Clearly, then,
there is great scope for discussion and conflict between
Islamic economists and Islamic lawyers. The latter group
may point out that even the Prophet was aware that goods
in the third group could be subsumed under the heading of
“foodstuffs” when he stipulated them. Nevertheless, he did
not levy zakat on all food items known at his time, but only
on certain ones. This fact must not be ignored.
There is also a need to interpret the original stipulations for
entitled recipients (see Fig. 3). Islamic economists consistently point to the poor and the needy as a group that is
of particular importance. However, without a definition of
need specific to a particular country and a
In times of economic downturn, the
number of people requiring support will
rise, while zakat receipts will decline.
This divergent relationship between expenditure and income must be covered
by reserves.
particular period, and the establishment of
the nature and level of help based on zakat
income, it is impossible to evaluate the
viability and the allocative and distributive
effectiveness of the system, let alone its
moral or ethical qualities. This is not the place to discuss
the hugely diverse concepts of Islamic economists in detail.
We can, however, draw attention to a particular problem,
which arises if we seek to understand zakat as the nucleus
of a social security system: in times of economic downturn,
the number of people requiring support will rise while zakat
receipts will decline. This divergent relationship between
expenditure and income, which is highly adverse for a
social security system, must be covered by reserves and,
perhaps, by additional sources of income. This requires
the technical knowledge of Islamic economists. Shariah
scholars probably have less to offer in this regard.
und Geldreform
▪ Förderung der Entwicklung
(Sparkassen-Projekt von
11|2010 KAS INTERNATIONAL
Mit Gahmr)
▪ Suche nach einem eigenständigen Wirtschaftssystem
Fig.
3
(Pakistan)
1960
Wachstum eigenständiger
arabischer Banken
87
REPORTS
1950
1940
Zakat as a social security contribution
Funding
Historical Basis
of Assessment
▪ Gold and silver
▪ Livestock
▪ Trade goods
Application
Modern Analogies
General
capital levy?
Entitled
Recipients
Social Security
▪ Poor
▪ Needy
Extensive inter- ▪ Debtors
▪ Travellers
pretation: for
nearly all govern- ▪ Redemption of
Slaves
ment duties
▪ For converts
▪ One of the highest duties of a Muslim
to Islam
▪ Basis in the Quran and Sunnah, details from Caliphs
▪ For warriors
▪ Social security system independent of the family
of Islam
▪ Elements of solidarity and subsidiarity
▪ Agricultural
produce
General
income levy?
No Tax (Self-Governance) ▪ Administration
of zakat
▪ Numerous open issues about details of adaptation/new interpretation
▪ Social security system with developable core
Financing
Acquisition of Goods/
Provision of
Aim: of
Services
Prohibition
Interest and Liquidity
the Shariah
FinancialTrade/Leasing
System
Profit and Loss Sharing
as Part of Financial and
Agreements (Bank as
Prohibited:
Investment Operations:
Intermediary/Lessor):
▪ riba (Interest
musharakaon
murabahah, ijarah
Conversely,
contributions
made by mudarabah,
Shariah scholars
on Loans)
▪ ghararof the financial system outweigh
topics
those
Islamic
Combination ofofTrade/
(Avoidable
Leasing Agreements:
economists
Shariah commercial
Uncertainity)(for the moment, at least).
commodity murabahah,
▪ maysir
tawarruq
law
is most developed and sophisticated
with respect to
(Gambling)
contract law (purchase, leasing, and
rental
agreements)
Securities with
Fixed
Permitted:
Returns: to
sukuk
▪ Profitsitfrom
while
is only rudimentary with respect
labour law.
“Ideal World”
of Islamic Economics, little
relevance in
practice
Common
practice of
Islamic banks,
very similar
to interest
Trade and
Wherever
Shariah provides sufficiently
detailed
contents,
Trade
Agreements
plus
Progressive
Leasing
One-Sided Promise
▪
One-Sided
this has to be considered when designing economic emulation of
Declaration of
(wa’d): Complex
conventional
the Inter-Bank Market,
questionable
Synthetic Products
for
techniques,
sub-systems.
on interestWill (Promise) This implies that the literature
free finance now relies more heavily
on legal texts than Shariah
Trading
it used to. Up until about the mid-1980s, scholars tended qualities
to draw less on legal sources for the Islamic content and
instead depended much more on principles they took
directly from the Quran, or rules based on the Sunnah.6
6 | For literature up to the 1980s cf. M.A. Mannan, Islamic Econo
mics: Theory and Practice (A Comparative Study) (Lahore:
Sh. Muhammad Ashraf, 1970); Muhammad Nejatullah Siddiqi,
Banking without Interest (Lahore: Islamic Publications, 1973);
Mohammad Ariff (ed.), Monetary and Fiscal Economics of
Islam (Jeddah: Kind Abdulaziz University, 1982); Ziauddin
Ahmed, Munawar Iqbal and M. Fahim Khan (eds.), Money and
Banking in Islam (Islamabad: Institute of Policy Studies, 1983).
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KAS INTERNATIONAL REPORTS 11|2010
As a result of more intensive interaction with Islamic
legal scholars, it became clear, however, that personal
interpretations of Islam’s primary sources – the Quran and
Sunnah – by economists did not satisfy the methodical
requirements of Islamic scholarship. In order to legitimize
something convincingly as Islamic, particular criteria
developed by Islamic theology and jurisprudence and
procedures for interpreting and applying the Quran and the
Sunnah (the tradition of the Prophet) must be taken into
account.7 However, the less the primary sources yield and
the less developed an area is within Islamic legal studies,
the more freedom Islamic economists have with respect to
the design of economic (sub-)systems.
For the financial sector there are particularly high levels of codification and
extensive legal writings.
The financial sector (financial institutions,
financial markets) is one sub-system for
which there are particularly high levels of
codification and extensive legal writings, which must be
taken into account when drafting rules and contracts.8
7 | Cf. Imran Ahsan Khan Nyazee, Theories of Islamic Law – The
Methodology of Ijtihad (Kuala Lumpur: Islamic Book Trust,
2002); Mohammad Hashim Kamali, Principles of Islamic
Jurisprudence (Cambridge: Islamic Texts Society, 2003);
Wael B. Hallaq, An Introduction to Islamic Law (Cambridge:
Cambridge University Press, 2009).
8 | Cf. Muhammad Ayub, Understanding Islamic Finance
(Chichester: Wiley, 2007); Brian Kettell, Introduction to
Islamic Banking and Finance (London: Brian Kettell, Islamic
Banking Training, 2008); Sudin Haron and Wan Nursofiza Wan
Azmi, Islamic Finance and Banking System – Philosophies,
Principles and Practices (Shah Alam: McGraw-Hill (Malaysia),
2009); Humayon A. Dar and Umar F. Moghul (eds.), The
Chancellor Guide to the Legal and Shari’a Aspects of Islamic
Finance (London: Chancellor Publications, 2009); Humayon
Dar and Talha Ahmad Azami (eds.), Global Islamic Finance
Report 2010 (London: BMB Islamic, 2010); Madzlan Mohamad
Hussain, Demystifying Islamic Finance: Correcting Misconcep
tions, Advancing Value Propositions (Kuala Lumpur: Zaid
Ibrahim & Co, 2010), https://www.zaidibrahim.com/wp
content/uploads/2010/05/Demystifying-Islamic-Finance-soft
copy.pdf (accessed October 17, 2010); Volker Nienhaus,
“Islamic Economics in Practice: Interest-Free Financial Manage
ment,” in: Werner Ende and Udo Steinbach (eds.), Islam in
the World Today: A Handbook of Politics, Religion, Culture,
and Society (Ithaca and London: Cornell University Press,
2010), 141-92 and 862-70; Zaharuddin Abdul Rahman,
Contracts and Products of Islamic Banking (Kuala Lumpur:
CERT, 2010); Ibrahim Warde, Islamic Finance in the Global
Economy, 2nd edition (Edinburgh: Edinburgh University Press,
2010).
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Within this sector, there are three prohibitions that must be
observed, namely those of:
▪▪riba, i.e. interest on loans,
▪▪gharar, i.e. avoidable uncertainty in transactions,
▪▪maysir, i.e. gambling.
The Islamic prohibition of interest could provide cause
for questioning the compatibility of the Islamic economic
system with that of the social market economy since
financial markets perform essential functions for a decentralized, competitive economy, in particular providing
savings for productive investments and managing risks.
It is difficult to conceive of capital markets without interest;
and without a capital market, the market economy cannot
function. However, we must be wary of a misinterpretation
at this point: although Islam does indeed ban interest on
loans, it does not deny the scarcity and potential productivity of capital, provided that it is combined
with labour (entrepreneurial efforts). Thus,
Islam does not forbid capital markets; it
merely requires certain modifications to the
conventional system.
Although Islam does ban interest on
loans, it does not deny the scarcity and
potential productivity of capital, provided that it is combined with labour.
▪▪Loan interest rates – strictly speaking, monetary interest
that is determined by transactions in the inter-bank
market and modified by the monetary policy of the
central bank – is not the only conceivable indicator for the
scarcity of capital. It is possible to structure investment
and financing decisions around average returns of stock
portfolios, for example, in order to determine a scarcity
price for (venture) capital. This was the case for early
models of the Islamic economy (between the 1970s and
1980s), which only recognized equity-like forms of savings
and financings and no debt relationships. The basic idea
was that, on the one hand, savers would not receive
fixed interest on their savings accounts, but shared in
the bank’s profits or losses, and that, on the other, banks
financed enterprises and projects on the basis of profit
and loss sharing (known as mudaraba, when only one
partner – the bank – provides the capital, and musharaka,
when both partners contribute the capital). Profit-sharing
ratios may be freely negotiated (as percentages of profit)
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but they must be specified at the beginning of the transaction and cannot be altered afterwards (to take account
of business developments, for example). Losses must
be borne proportionately to the capital shares of the
investors (in the case of mudaraba, by the bank alone; in
the case of musharaka, by both partners). Such a financial
system faces the problem that returns on participation
finance and equities, such as stocks, are not certain and
instead are subject to a degree of fluctuation, i.e. risk.
This makes direct comparisons of alternatives difficult.
▪▪Nowadays, Islamic financial market models are, by
contrast, based on a broader spectrum of investment
and financing instruments that includes broadly risk-free
forms of finance and debt instruments that are allowed
under Shariah law (see below). Actual models use such
returns as scarcity indicators.
What had initially been neglected in theoretical models
became an important foundation of financial transactions
in the practice of Islamic banks since the end of the 1970s:
although the Quran does prohibit interest on loans, it
explicitly encourages trade and trade profits.
It is possible to replace a bank loan
with a system whereby the bank acts
as an intermediary and acquires the
objects needed on the client’s behalf.
Since borrowers in the majority of cases do
not require liquidity for and of itself, rather
require
it
to
acquire
merchandise,
raw
materials, machines, and other objects, or
to pay for services, it is possible to replace a bank loan
with a system whereby the bank acts as an intermediary
and acquires the objects needed on the client’s behalf,
pays the supplier directly, and sells these objects on to
the client for a fixed markup on the purchase price (or, by
analogy, commissions services). The client then pays the
purchase price and the profit markup at a later date either
as a lump sum or in installments to the bank. The bank’s
profit markup is analogous to economic interest; however,
legally-speaking it is a trade profit and is thus not affected
by the prohibition of riba. Trading operations (known as
murabaha) also differ in other respects (particularly with
regards to liability and transfer of risk) from loan transactions, meaning that the boundaries between permissible
trade profits and prohibited interest are quite clear.
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It must be emphasized, that Shariah concerns Islamic law
and, thus, any judgments about the legitimacy of transactions is based on legal and not on economic criteria.
Since Islamic economists were searching for an economic
(material) rather than a legal (formal) alternative to
interest, they neglected (quite rightly so from their point
of view) the (debt) financing techniques
based on intermediary trading since they
were legally permissible but did not get the
system any further economically compared
to the status quo of interest-based finance.
For the practical operations of Islamic banks,
In countries with a lack of regulatory
provisions, low levels of transparency,
poor business ethics, and a legal system
with deficient enforcement powers,
financing based on profit and loss sharing harbors a great risk for the bank.
however, this situation is considerably different: in countries with a lack of regulatory provisions, low
levels of transparency, poor business ethics, close links
between the political and economic elites, and a legal
system with deficient enforcement powers, financing based
on profit and loss sharing harbors a great risk for the bank:
For entrepreneurs who are more interested in the bottom
line of their balance sheet than in Islamic values, finding
a partner who will share losses of a risky business (if the
actual risks are cleverly concealed) is an attractive proposition, while sharing expected profits is less appealing.
There is much to indicate that participation financing
systematically attracts above-average levels of risk without guaranteeing above-average profits. Therefore, in
practice, Islamic banks tend to focus on (debt) financing
on the basis of trade agreements (murabaha) and other
permissible rental or leasing transactions (known as ijara).
Islamic financial practice has, though, not just limited itself
to these rudimentary financing instruments; rather, it has
expanded its tool set in two important directions. To date,
Islamic economists have rarely integrated these adequately
into their macroeconomic models and are, therefore, more
inclined to an overly optimistic assessment of the stability
and allocative qualities of an Islamic financial system:
▪▪The first direction is the provision of liquidity at fixed
costs/returns by a combination of trade transactions.
In the original model, Islamic banks could only provide
liquidity on the basis of profit and loss sharing, which
presented two problems: on the one hand, the risks
associated with this, and, on the other, the exact costs/
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KAS INTERNATIONAL REPORTS 11|2010
returns, which could only be known retrospectively. A
classic and prohibited method for evading this would
involve just two parties in a trade transaction, where the
bank’s client and the supplier of the commodity were one
and the same: the client would sell the bank an object
for immediate payment and then repurchase it for later
payment at a markup. The legal verdict is,
Combined trading known as “commodity murabaha” is heavily criticized by
some Islamic economists, as the banks
have developed an instrument that is
compatible with Shariah law, but can
completely replicate, from an economic
perspective, interest-bearing loans.
however, different if three or four parties are
involved in the same business. If the bank’s
client is primarily interested in liquidity and
not in the commodity purchased by the
bank, the client can then sell the commodity
acquired from the bank to another party for
immediate payment. As a result, (1) the bank has made
a payment today and has received a claim for a higher
payment in the future, and (2) the client has received
payment today and has a liability for a higher payment in
the future. Neither the bank nor the client possesses the
commodity. In extreme instances, the customer could sell
the object back to the supplier. If that were considered
unacceptable, the client (with or without the bank’s help)
would have to find another buyer. This is not particularly
difficult if the commodity is one that can be traded on
the stock exchange – such as platinum, which is traded
by many brokers on the London Metal Exchange. Such
combined trading (known as commodity murabaha or
tawarruq) is now commonplace among Islamic banks both
for finance transactions with non-banks and in interbank
transactions (as part of their liquidity management). It
should come as no surprise that this practice is heavily
criticized by some Islamic economists, as the banks
have developed an instrument that is compatible with
Shariah law, but can completely replicate, from an
economic perspective, interest-bearing loans (with the
exception of the marginally higher transaction costs as
a result of broker commissions). Inspite of this criticism,
Islamic banks along with Shariah scholars have made
great efforts over the past few years to emulate conventional financing methods – from simple options through
complex derivatives to hedging and total return swaps –
in a form that complies with Shariah law. Many of the
results of this special form of “contract engineering” are
highly controversial in terms of their structure, but have
the blessing of prominent Shariah scholars and are used
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by parts of the Islamic finance industry. This has led to
a broad debate about “form over substance” within the
Islamic financial sector, which has failed to yield any solid
results as yet (aside from increased public awareness of
the problem).
▪▪The second direction of expansion for Shariah-compatible
instruments is the creation of tradeable securities that
resemble fixed-interest securities in their economic
character but are equity-based as they incorporate
ownership rights: so-called sukuk (Islamic bonds) are
created when companies, who are looking for finance for
a fixed period of time, transfer ownership of such assets
which generate a stable income stream (by
long-term rental, for example) to a special
purpose vehicle (SPV). The SPV then issues
certificates on the capital markets equal to
the value of the object transferred; these
In reality, many sukuk do not involve
an actual transfer of ownership. Only
the usufruct is transferred and not the
asset itself.
certificates give the holders the right to a share in the
securitized income stream. This income stream mostly
comes from the original owner of the object who leases
the object back from the SPV (similar to conventional
sale-lease back methods). Based on a strict application of
Shariah criteria, the right to an income stream is derived
from the fact that the certificates constitute (partial)
ownership of the SPV’s assets from which the income
stream is generated. In this instance, the certificates
may be traded without restrictions as Shariah-compliant
equities. In reality, however, many sukuk do not involve
an actual transfer of ownership. Only the usufruct
(the right to utilize, i.e. the title to the rental income)
is transferred and not the asset itself (i.e. the leased
real-estate). The difference becomes clear in instances
where the sukuk issuer (the SPV) goes into insolvency or
files for bankruptcy: in the case of “real” title deeds, the
holders may hope to recover part of their capital through
the sale of the asset, while the capital is lost completely
in the case of certificates which only securitize the income
stream that has now dried up. Seen from the perspective
of Shariah law, many sukuk are not just criticized for
these diluted or very restricted ownership rights, but also
because of a buy-back guarantee of the issuer for the
certificates at their issue price when the term ends. By this
the on-going returns and capital expenditure are known,
Funding
94
Application
KASAnalogies
INTERNATIONAL REPORTS
Modern
Entitled 11|2010
Recipients
Historical Basis
of Assessment
meaning that a de facto interest-bearing instrument has
▪ Gold and silver General
Social Security ▪ Poor
▪ been
Livestock
created.capital
Whilelevy?
buy-back guarantees▪ Needy
as such
▪ Trade goods
are
permissible, prices must equate to the actual market
▪ value
Agricultural
of the
produce
General
Extensive
inter- ▪ Debtors
asset
at the time
the buy-back
is effected
income levy?
pretation: for
▪ Travellers
(and not be fixed at the issue
price
or market
valueofat
▪ Redemption
nearly
all govern-
Slaves
duties
the time of the issue). If thement
buy-back
were
transacted
▪ For converts
▪ One of the highest duties of a Muslim
at actual market prices, this implies considerable
risks for
to Islam
▪ Basis in the Quran and Sunnah, details from Caliphs
▪ For warriors
of a sukuk
compared
to an interest-bearing
▪ the
Socialreturns
security system
independent
of the family
of Islam
▪ Elements of solidarity and subsidiarity
bond, since this market value is not known at the time of
No Tax (Self-Governance) ▪ Administration
of zakat
issue and may decrease over time.
▪ Numerous open issues about details of adaptation/new interpretation
Fig.
4 security system with developable core
▪ Social
Prohibition of Riba and Islamic Finance
Financing
Aim:
Shariah
Prohibited:
▪ riba (Interest
on Loans)
▪ gharar
(Avoidable
Uncertainity)
▪ maysir
(Gambling)
Acquisition of Goods/
Services
Trade/Leasing
Agreements (Bank as
Intermediary/Lessor):
murabahah, ijarah
Permitted:
▪ Profits from
Trade and
Leasing
▪ One-Sided
Declaration of
Will (Promise)
Provision of
Liquidity
Profit and Loss Sharing
as Part of Financial and
Investment Operations:
mudarabah, musharaka
Combination of Trade/
Leasing Agreements:
commodity murabahah,
tawarruq
Securities with Fixed
Returns: sukuk
Trade Agreements plus
One-Sided Promise
(wa’d): Complex
Synthetic Products for
the Inter-Bank Market,
Trading
Shariah, Islamic Economics, and the Social
Market Economy
Without going into further complexities of an Islamic
financial system, what has been discussed thus far is sufficient to corroborate two important theses.
▪▪The first thesis is that the formal restrictions, which stem
from the requirements for Shariah-conformity, do not
prevent the construction of a sophisticated and efficient
financial system and capital market – without which
the social market economy could not function. In view
of the current global financial crisis, such a strong link
between the financial sector and the real economy, and
a limit to the development and application of synthetic
“Ideal World”
of Islamic Economics, little
relevance in
practice
Common
practice of
Islamic banks,
very similar
to interest
Progressive
emulation of
conventional
techniques,
questionable
Shariah
qualities
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11|2010 KAS INTERNATIONAL REPORTS
financial products for speculative and high-risk purposes
is, perhaps, more beneficial than detrimental for a social
market economy. Against the backdrop of replications
of problematic, conventional techniques and products
that conform to Shariah law, the calls by
Islamic economists – which perhaps go a
little too far – for every financial transaction
to be based on a real economy transaction
can also be understood in some respects
as self-criticism, or at least a warning to
Islamic financial engineers.
Islamic economic systems are indeed
compatible with the concept of the
social market economy, and Islamic
economics can act as an advocate of
such a concept transfer. Nevertheless, this alone would not bring much
benefit.
▪▪The second thesis is that Islamic economic systems are
indeed compatible with the concept of the social market
economy, and that Islamic economics can act as an
advocate of such a concept transfer. Nevertheless, this
alone would not bring much benefit as the political effectiveness and the practical relevance of Islamic economics
as an academic discipline is relatively weak at a systems
level, and this influence has tended to wane rather
than wax over the past twenty years. On the one hand,
following the collapse of Communism, major questions
about economic systems – and hence the search for a
third way – have rather lost their political importance. At
the same time, though, a devaluation of the prescriptive
parts of Islamic economics is taking place, which give
general recommendations for the structure of an Islamic
economic system. Ever since market-based concepts
have started to find broad political acceptance, the
specific
legitimization
of
economic
sub-systems
by
Islamic teachings and methods of reasoning has lost
some of its appeal because many people are able to
agree relatively quickly about system issues irrespective
of their ideological background.
This poses a particular problem for an academic discipline such as Islamic economics which continues to be
more prescriptive and to create models that are mainly
focused on abstract systems rather than offering theories
with explanatory power concerning the behavior of
actual Muslims. This is particularly clear in the continued
attention given to unrealistic profitand-loss sharing
models of a Shariah-compliant financial sector while the
business models of real Islamic financial institutions are
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KAS INTERNATIONAL REPORTS 11|2010
moving in a different direction (replicating interest-based
instruments and structured products). The level of selfcritical reflection is still relatively low. Nevertheless, an
increasing number of empirical studies are being carried
out, which illuminate at least some excerpts of Muslim
economic realities (such as savings or consumer behavior
of particular groups of Muslims, their attitude towards
Islamic banks, the causes of low zakat receipts, labour
migration issues, the effects of Islamic microfinance
initiatives, etc.).
Even if the times of great controversies for economic
systems have passed, it is still prudent to extend the
dialog to specific issues relating to economic sub-systems
outside the financial sector. Academic insight is likely to
be much greater in this area and collaboration could lead
to improvements in the standards of living in the Muslim
world. There are promising starting points in several
fields, where explicit reference to Islamic teachings and
collaboration with recognized Islamic authorities has
already proved very helpful. For example, these include
local environmental protection and water conservation, the
development and popularization of corporate governance
standards, the proliferation of microinsurance, and social
security systems for disadvantaged groups within the
population.